What future for Mercosur?

Canning House commissioned a paper to investigate the future Latin America’s largest trade bloc. It has had a tough decade but still has the potential to reward investors…

Mercosur brings together around 300m people across a territory of almost 15 million square kilometres, boasting incredible biodiversity, fertile farmlands, and extensive energy resources. The bloc was conceived in 1991, a time of increasing multilateralism, and was made possible by rapprochement between long-time rivals Brazil and Argentina. Its founding document, the Treaty of Asunción, calls for the “free movement of goods, services, and factors of production between countries,” and in 1994 the Mercosur nations agreed to a customs union with a common external tariff (CET).

What has Mercosur achieved so far?

The early years of Mercosur were a great success, and the 1990s are known as the bloc’s “golden age” as both international trade and trade between member states grew rapidly. Tariff protection plummeted and non-tariff barriers were also reduced, and at the same time cooperation increased and border tensions and arms competition decreased. However, Mercosur then missed its deadline to fully implement a customs union in the year 2000, and it remains incomplete to this day due to the persistence of “Lists of Exceptions,” which allow member states to apply different import tax rates. In addition, Brazil’s currency devaluation in 1999 and Argentina’s massive 2001 economic crisis shook the bloc’s foundations and slowed the process of integration.

Despite these difficulties, efforts to expand the bloc followed. For example, Venezuela became a full member of Mercosur in 2012, but political tensions made for rocky relations and the country was suspended from the bloc in 2017. Bolivia started the accession process in 2012, but it remains an associate member pending approval of its full membership application by Brazilian lawmakers. Other associate states, which enjoy some trade benefits but are not members of the customs union, include Chile, Colombia, Ecuador, Guyana, Peru, and Suriname. As for trade deals, Mercosur has been slow to open to international markets. There is no agreement with the US, after Mercosur rejected the idea of a 34-nation Free-Trade Area of the Americas (FTAA) proposed by Washington in 1998. And Mercosur took 20 years to negotiate a trade deal with the EU, which was finally reached in 2019 but is yet to be ratified. That same year a deal with the European Free Trade Association (EFTA), which comprises Iceland, Liechtenstein, Norway, and Switzerland, was agreed, but it too remains unratified. And in July 2022 Uruguay’s announcement that it would pursue a separate free trade deal with China sparked yet more tensions within Mercosur.

Member states are continually negotiating the CET, which averages 10%-12%, as well as changes to rules governing exceptions and other trade barriers, and supranational institutions have been developed to facilitate this. However, these institutions remain weak compared to their counterparts in the EU, for example, lacking the autonomy to uphold the rules of the bloc. Presidential power predominates in Mercosur negotiations, leaving the interests of the bloc vulnerable to being overpowered by domestic priorities. This has become increasingly important as member states have had to deal with political and economic turmoil in recent years, linked to falling commodity prices, corruption scandals, the Covid-19 pandemic, and the fallout from Russia’s invasion of Ukraine. At the same time, Mercosur has failed to maintain its early record of increasing trade between member states, which peaked in 2013 at $48.9billion. In recent years intra-bloc trade has decreased from $39.8billion in 2018 to $32.7billion in 2019 and $28.7billion in 2020, before rebounding to $40.6billion in 2021, the latest figures available.

Economic interdependence between member states has been weakening as external economies such as China have increased their share of trade compared to intrazonal trade which has made raw materials more important in Mercosur’s trade balance and exposed the bloc’s low involvement in global value chains. Mercosur is still one of the largest economic blocs in the world, but it remains a flawed customs union rather than a common market. Macroeconomic developments have encouraged member states to return to protectionist measures and thrown down further obstacles to integration. The question is whether Mercosur can overcome these longstanding difficulties to fulfil its potential, or if fundamental differences between member states mean the bloc is doomed.

What next for Mercosur?

For Mercosur to progress there are many issues that need to be resolved, including reducing the level of Mercosur’s common external tariff (CET) and the high number of exceptions to the CET; the potential readmittance of Venezuela to the bloc and the accession of Bolivia; and negotiating new trade deals with external partners at a time when protectionist instincts are running strongly.

However, the coming to power of President Lula da Silva in Brazil, Mercosur’s largest economy and most influential member, could have a huge influence on the direction of the bloc. First of all, ‘Lula’ is scheduled to travel to China early this year, and Beijing may ramp up pressure to agree to an FTA, either as a bloc or individually. As things stand a joint FTA with China appears unlikely given the internal divisions of the bloc, but pressure from both Beijing and Brasilia could be brought to bear on other members. A potential deal could exclude some vulnerable sectors of industry, and include a phasing in process that provides for the gradual reduction of bilateral tariffs, as the EU deal does. This would allow Mercosur time to adapt and become more competitive.

According to Uruguay’s former president José Mujica (2010-2015), Lula is likely to try and find a compromise position with Montevideo over more flexibility in bilateral negotiations. As for the EU deal, it appears that there will be a renewed push to finalise the deal in Brussels as well as Brasilia. European officials don’t want to lose influence in South America, particularly as China continues to grow in prominence in the region, but while Lula has said that his government will promote the deal, he has also said that it should be renegotiated to the benefit of Brazilian industry. This will not be an easy process, and Lula himself has said there is “no need to rush” to implement the agreement. Debates around the CET will also continue. While member states agree that the CET is high compared to tariffs in most countries or trade blocs, there is as yet no agreement on the speed, coverage, and percentage of any reduction. Lula has also promised to expedite Bolivia’s accession to the bloc as a full member, but opposition lawmakers control both upper and lower houses of congress, which will make it harder for the president to enact his agenda. As for Venezuela, it appears that relations will continue to normalise throughout the year, with Lula driving South-South cooperation as promised in his government programme.

It is hard to deny that the bloc has failed to fulfil its potential, and that it faces many entrenched internal and external challenges. However, there is at least a possibility that 2023 could provide evidence of a desire to progress. Much will depend on the ambitions and influence of the new administration in Brasilia.